China can fix its econ­omy

The Pak Banker - - OPINION - Keyu Jin

PES­SIMISM about China has be­come per­va­sive in re­cent months, with fear of a "China melt­down" send­ing shock waves through stock mar­kets world­wide since the be­gin­ning of the year. And prac­ti­cally ev­ery­one, it seems, is go­ing short on the coun­try. There is cer­tainly plenty of rea­son for con­cern. GDP growth has slowed sharply; cor­po­rate-debt ra­tios are un­prece­dent­edly high; the cur­rency is slid­ing and equity mar­kets are ex­cep­tion­ally volatile. The ques­tion is why this is hap­pen­ing, and whether China's au­thor­i­ties can fix it, be­fore it is too late.

The pop­u­lar - and of­fi­cial - view is that China is un­der­go­ing a tran­si­tion to a "new nor­mal" of slower GDP growth, un­der­pinned by do­mes­tic con­sump­tion, rather than ex­ports. And, as usual, a hand­ful of eco­nomic stud­ies have been found to jus­tify the con­cept. But this in­ter­pre­ta­tion, while con­ve­nient, can pro­vide only false com­fort.

China's prob­lem is not that it is "in tran­si­tion." It is that the state sec­tor is chok­ing the pri­vate sec­tor. Cheap land, cheap cap­i­tal and pref­er­en­tial treat­ment for state-owned en­ter­prises weak­ens the com­pet­i­tive­ness of pri­vate firms, which face high bor­row­ing costs and of­ten must rely on fam­ily and friends for fi­nanc­ing. As a re­sult, many pri­vate firms have turned away from their core busi­ness to spec­u­late in the eq­ui­ties and prop­erty mar­kets.

Chi­nese house­holds are also squeezed. In just 15 years, house­hold in­come has fallen from 70 per­cent of GDP to 60 per­cent. Un­less Chi­nese house­holds are able to reap their fair share of the ben­e­fits of eco­nomic growth, it is dif­fi­cult to imag­ine how a con­sump­tion boom is sup­posed to hap­pen. Clearly, China must take bold steps to un­leash the dy­namism of the pri­vate sec­tor and boost house­hold de­mand.

China has proved its ca­pac­ity to im­ple­ment rad­i­cal re­forms that elim­i­nate ma­jor dis­tor­tions, thereby boost­ing growth and ab­sorb­ing ex­cess debt. In the late 1980s, fall­ing GDP growth (the an­nual per capita rate reached a low of 2 per­cent in 1989) and a ris­ing vol­ume of non-per­form­ing loans (NPLs) fu­eled ex­pec­ta­tions of an eco­nomic im­plo­sion.

It never came. In­stead, the Chi­nese govern­ment launched a raft of rad­i­cal re­forms, in­clud­ing large-scale pri­va­ti­za­tion of in­dus­try and elim­i­na­tion of price con­trols and pro­tec­tion­ist poli­cies and reg­u­la­tions. As the state's share of non-agri­cul­tural em­ploy­ment fell - from 30 per­cent in the mid-1990s to 13 per­cent by 2007 - pri­vate-sec­tor pro­duc­tiv­ity rose at an av­er­age an­nual rate of 3.7 per­cent from 1998 to 2007. State-sec­tor pro­duc­tiv­ity grew even faster, at 5.5 per­cent per year. This pro­duc­tiv­ity growth con­trib­uted about one-third of China's to­tal GDP growth - which ac­cel­er­ated to dou­ble-digit rates - over this pe­riod. China's en­try into the World Trade Or­ga­ni­za­tion in 2001 - an­other bold step - was a ma­jor fac­tor in this suc­cess.

This time around, how­ever, the task fac­ing China's govern­ment is com­pli­cated by political and so­cial con­straints. The eco­nomic re­forms China needs now pre­sup­pose political re­form; but those re­forms are ham­pered by fears of the so­cial reper­cus­sions. If China is to avoid eco­nomic de­cline, it will have to over­haul its gov­er­nance sys­tem - and the phi­los­o­phy that un­der­pins it - with­out trig­ger­ing ex­ces­sive so­cial in­sta­bil­ity.

The good news is that China has a promis­ing track record on this front. Af­ter all, it was a fun­da­men­tal ide­o­log­i­cal shift that en­abled China's 35-year-long eco­nomic boom. That shift em­pha­sized eco­nomic de­vel­op­ment above all else, with the cham­pi­ons of growth be­ing pro­tected, pro­moted, and, if nec­es­sary, par­doned. A sim­i­lar ide­o­log­i­cal shift is needed to­day, only this time the fo­cus must be on in­sti­tu­tional de­vel­op­ment. Sus­tain­able longterm growth - based on ef­fi­ciency im­prove­ments, pro­duc­tiv­ity gains, and in­no­va­tion - is pos­si­ble only with an ef­fec­tive in­sti­tu­tional frame­work, and that re­quires fun­da­men­tal changes to the political and reg­u­la­tory sys­tems. Only by overcoming vested in­ter­ests and build­ing a more ef­fi­cient bu­reau­cracy, bound firmly by the rule of law, can the re­forms China needs be pushed through.

Com­pli­cat­ing mat­ters fur­ther are mount­ing so­cial con­flicts, such as be­tween ur­ban and ru­ral pop­u­la­tions, among in­dus­tries, and be­tween the pri­vate and state sec­tors. The po­ten­tial for mass protests and civil un­rest is now ham­per­ing the govern­ment's de­ter­mi­na­tion to cre­ate change. China's ex­pe­ri­ence in the 1990s sug­gests that the coun­try can bounce back from its cur­rent strug­gles. With ma­jor re­forms only half-com­plete, there are sig­nif­i­cant op­por­tu­ni­ties for sta­ble growth based on ef­fi­ciency and pro­duc­tiv­ity gains, rather than merely on con­sump­tion.

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